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Dow’s New High a Gently Cheered Win for the Defense

The Dow Jones Industrial Average’s move to a new all-time high was a victory achieved with the defense spending most of the time on the field, fending off perilous threats while the offense scored just enough to win.

This isn’t meant to damn the rally with faint praise, to declare “sour grapes” or charge that there’s anything suspect about the long-tenured market barometer’s surmounting of its 2007 peak. Relative to corporate profits, the size of the U.S. economy or the valuation of corporate debt, the Dow’s push to a fresh, if marginal, high, is right in line with historical norms.

Rather, crediting the defense is to recognize that, in recent months, the stock market has impressively found a way to withstand some political pseudo-crises, unceasing global-growth fears and some financial-crisis aftershocks.

Dow keeps marching on

Since the market jetted higher to start the year and began to look overbought and over-loved – prompting widespread calls (by this column and elsewhere) for a well-needed pullback to reset investor expectations and refresh buying power – the Dow did nothing but a quick little stutter-step, dipping 2% before bursting above 14,200.

With the help in recent weeks of defensive sectors such as consumer staples and healthcare, the market bided its time and recouped strength by sidling sideways as cash rotated among sectors rather than leave the market – until the “offense” re-emerged in the form of transportation and industrial stocks.

The Dow’s role as lead index, outperforming the broader Standard & Poor’s 500 and small-cap Russell 2000 of late, is itself a sign of a standout defense: It is made up of huge, slower-moving, mostly stable multinationals, and bullish investors would prefer if more-aggressive indexes were leading the charge.

A clunky but well-traveled watchword of this rally has been “divergences.” This is trader-wonk jargon for internal market behavior that appears at odds with what the headline indexes have been doing.

In the present case, observers have quibbled that the buying hasn’t been on powerful volume, Treasury yields have remained stolidly below the slow-growth 2% level, the Chinese market rolled over, commodity-based stocks that usually benefit from rising growth hopes have lagged, junk bond spreads briefly wobbled, market volatility flared and then fizzled.

A culmination -- not a beginning

Further, professional investors have, by some measures, gotten aggressive in expanding their exposure to stocks, including with borrowed funds. B of A Merrill Lynch strategist Mary Ann Bartels this week noted that margin borrowing rose to levels triggering a tactical sell signal in her market model. These clues all hint that, in the very short term, this spurt appears to be more the culmination of a rally phase than the very beginning of one.

So, it would be no surprise if the market roughly followed the path of the past couple of years, when a first-quarter rally gave way to a choppier, downward-probing phase, come spring.

This doesn't mean the market should flop flagrantly from here but that we’ve stretched our way up to unseen heights from conditions that suggested we were already overdue for a rest. Such a setup weighs on the risk-reward calculation.

Of course, timers of market pullbacks can’t follow a recipe on the back of a cake box to get the treat they’re hungry for. The outperformance of stocks over commodities, amid a firm U.S. dollar and declining gold prices, hint at the possibility of an emerging period when stocks are not merely treated as another generic “risk asset” along with all others. Such a shift would represent the further maturing of an already long-established bull market.

Another sort of perceived "divergence," though, might be more important for the bigger market picture - one that stretches beyond whatever digestion or correction interlude should arise.

An unearned bounty?

This is the broad public’s sense that the Dow's trading at a new high is itself a divergence from the dominant economic story of the moment – a narrative that continues to focus on a slack job market, a stalled American growth engine, government-deficit alarmism and a broken promise of ever-advancing generational prosperity. The tone of mainstream commentary about the Dow setting a new record – one not far above levels reached five and 1/2 and 13 years ago, mind you – suggests the market’s bounty is unearned, artificial or perverse in the face of a downbeat societal mood.

Some professional investors are prone to this notion as well, carping last year, for instance, that Apple Inc. (AAPL) alone was pulling the indexes higher, and this year insistent that the Federal Reserve’s asset-purchase program is almost solely responsible for strong equity prices.

Yet Apple has dropped 40% in six months, the Fed’s support is more context than direct market catalyst, and stock values have mostly just adjusted upward in step with corporate-credit indicators, the drop in unemployment claims and the ebbing of the market’s estimation of macro-shock risk.

The fact that these perfectly reasonable explanations for the present level of the market are largely dismissed, in favor of notions of investor delusion or asset-price manipulation, suggests the reservoir of skepticism remains helpfully full.

No bull market is guaranteed a long, festive finale with the greedy crowds piling in and congratulating one another on their good fortune. In 2007, in fact, the “little guy” never really showed up in time to party before the roof caved in, and he might not this time before the market's run is through.

But if this go-‘round is to include an eventual public embrace, it will probably come with the Dow a bit higher than today’s quote – and with the offense on the field.

Follow me on Twitter @michaelsantoli.